Now It’s Your Churn: Catching a Cheating Stock Broker

Newsday (New York), January 11, 2004 (John F. Wasik)

As the new year unfolds, you need to ask yourself incisive questions about your mutual funds and brokerage accounts. The meaningful question, though, isn’t “Did I get fleeced by mutual funds trading after hours with hedge funds?” You may never know how your funds were pinched by these practices.

Instead, ask if your portfolio of funds and individual securities was overcharged or churned, that is, traded excessively to generate expenses and commissions that reduce your total return.

Don Onofrey, who started investigating his broker when his tax preparer noticed steep losses in his brokerage account portfolio, didn’t like the answer he received. His broker, a man he knew and trusted since high school, was churning his mutual funds to generate commissions – and losing more than $79,000 of Onofrey’s nest egg in the process.

“At first, he [the broker] denied that he had lost the money,” Onofrey said. “Then he placed a handwritten note in my mailbox admitting the losses. We used that as evidence in my arbitration case.” Onofrey, a computer professional from Gary, Ind., took action by filing an arbitration claim against his broker, who had a record of disciplinary actions at several firms. Arbitration is the process in which uninvolved third parties settle a dispute and can order monetary awards if they find in your favor, a common practice in the securities business. Arbitrators awarded Onofrey $104,547 in restitution and punitive damages, of which he kept $69,000 after lawyer’s fees.

“The brokerage statements were coming fast and furious, so I didn’t check. Now I scrutinize every piece of paper,” Onofrey said.

You wouldn’t be alone if you thought something smelled like rotten fish in your brokerage accounts or retirement plan and wanted to do something about it. Last year, there were 11,000 suits filed against employer retirement plans alone, an increase of 9 percent from the previous year, according to the Administrative Office of the U.S. In 2001, the increase was 13 percent.

Being vigilant with your portfolio involves: 1) looking for red flags that a broker or fund company, either directly or through your retirement plan, is overcharging you, and 2) transferring your money into lower-cost/higher-performing funds.

Let’s start with your 401(k)-type funds, one of the areas where investors least expect wrongdoing and where you are most likely to be overcharged.

Go to your fund administrator or human resources department and ask for the total cost of administering and managing your funds, including undisclosed charges for soft dollars and revenue sharing. “The largest component of 401(k) performance is expenses,” says Pam Hess, a consultant at Hewitt Associates, a corporate benefits company. “Many employees don’t realize there are plan fees.” Here are some 401(k) annual average expenses Hewitt has compiled for several types of funds:

Global stock fund: 1.92 percent

Large-company growth stock fund: 1.56 percent

Small-company value fund: 1.53 percent

Balanced stock-bond fund: 1.45 percent

Intermediate-term bond fund: 1.06 percent

Few employees check these costs since they may not realize that nearly all retirement plan expenses in 401(k)s come out of their pockets. You can find lower-cost funds and increase your total return immediately. Chances are good that you or your employer can beat the averages listed above by finding higher-performing funds in the lowest-cost “institutional class.” You can also cut returns-eating expenses by moving into lower-cost fund groups not sold through brokers.

Does your employer’s plan qualify for institutional savings? Hess says if total plan assets are at least $10 million, your employer can reap huge fee discounts, “although a surprising number of large plans don’t take advantage of institutional shares.” The average expenses, for example, on an institutional-class Standard & Poor’s 500 stock fund – a staple in most 401(k) plans – is 0.09 percent annually, vs. 0.70 percent for a retail S&P 500 fund, according to Hewitt.

If your employer qualifies, but is not providing institutional class funds in your retirement plan, you could be overcharged by a factor of 7. Once you get an answer from your employer, take a look at your brokerage or mutual fund statements. You can be churned and overcharged in mutual fund holdings as well as single securities.

Andrew Stoltmann, a Chicago securities lawyer who specializes in individual investor arbitrations and represented Onofrey in the NASD arbitration, says that a telltale sign for churning is if a broker trades your portfolio or funds more than 200 percent a year. That means your entire portfolio has been completely sold off more than twice annually.

In Onofrey’s case, his broker had turned over his portfolio 13 times between January 1999 and March 2000, even though Onofrey said he was “not willing to take extensive risks.” Unfortunately, Stoltmann has found that most aggrieved investors don’t get past calling their broker to complain. “Some 99 percent of investors with an actionable claim against Wall Street don’t pursue it,” he says.

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